Microsoft uses a technology called Volume Shadow Copy to make these backups. It's a very clever approach because it allows full volume sector-by-sector backups (like a Ghost image) that can be stored incrementally. If you backup every day, each additional copy only consumes the space required to store the changes, yet still looks like a full stand-alone image.
The combination of VHD (a convenient pre-existing disk image format) and Volume Shadow Copy makes it trivial to restore to any point in time (that you have a backup of).
Why are these image (or sector-based) backups useful?
1) Sector-based backups are orders of magnitude faster than file-based ones. In a sector-based backup the disk heads are moving sequentially whereas in a file-based backup the heads are moving randomly. In many cases this means the difference between backups being able to complete overnight or not.
2) You can do a complete system restore simply by booting from the Vista/Windows 7 DVD and going through the option of recovering your system. This covers scenarios like failed hardware or malware damaging your OS.
3) They are very space-efficient. Think of a 100 MB database file. If you do incremental file-based backups, every new backup will consume 100 MB. On the other hand, a sector-based incremental backup will only consume the space necessary to store the changes to the 100 MB file, which could be as small as a single sector.
Microsoft's use of the VHD format was a logical choice that saved them creating a new format -- a laudable approach in my opinion (the less "standards" the better). Think about it; with VHDMount I can now mount full-disk backups AND Virtual PC/Hyper-V virtual disks -- what's not to like? Nowhere in all that is the implication that an image of a computer will boot on completely different hardware (which is what Virtual PC/Hyper-V are equivalent to).