What is it?
Windows Product Activation is a technology devised by Microsoft for its new XP products. This includes Windows XP and Office XP. Apparently their goal is to prevent users from using a single CD to install many copies of the software.
How does it work?
Let's assume you have just bought a new computer without an existing installation of Windows XP. When you install the OS, it generates a so called Hardware ID (HWID) based on the hardware you have installed. You then have 30 days to register your copy of Windows via the Net or phone. The HWID is sent to Microsoft along with a unique Product ID, which came with the CD, and based on these two numbers, they send you back a code you use to register Windows.
Problems
The HWID is generated based on your hardware, so what if you change that hardware? Suppose you're deeply dissatified with the fact that Quake III only gives 50 fps, and that new GeForce 3 looks mighty fine. When you install the new board, the HWID also changes, and the the key used to register Windows is now invalid. Fortunately, Microsoft has implemented a system called "tolerance", which dictates that the HWID is allowed to change to a certain degree. If this tolerance is exceeded, you apparently have to phone in to Microsoft's tech support and explain to them just why your system has just changed.
It should be noted, though, that at this point it's still unclear what hardware features are used to calculate the HWID. It could be that something as simple as changing a DMA or IRQ setting might be enough to cause the HWID to change.
And what of larger companies, say the ones that have around 50,000 computers? According to this scheme they would have to buy 50,000 CD's to install Windows XP to every computer. To combat this problem, Microsoft plans to issue special versions of the OS, which have the WPA disabled. How long do you think it takes for this version to be pirated and distributed around the world?
Update 21 october, 2001: Well, it didn't take long. In fact, the pirated version of the non-WPA encumbered XP has been available for some time in Morpheus for example, and the OS isn't officially released yet!
It seems to me that it's only a matter of time that this system is defeated completely, either by pirated copies of the non-WPA version, or by handy H4x0rs finding a way to generate the registration keys with a key generator. Microsoft will not only be unable to prevent piracy or breaches of the EULA, but they will also make the life of honest users more difficult.