Microsoft appears to be approaching the idea from at least two different directions. One method attempts to create a "magic wall" by combining a massive display powered by innovative "flat lens" LED technology with motion tracking and touch-input technology. The imagined result is an interface that can display detailed content and respond to a variety of touch and motion gestures.
Microsoft's current prototype "window" already supports glasses-free 3D by beaming specific stereoscopic images to each of your eyes, and it's able to beam different images to different users. Basically, you could be immersed in one scene while your friend standing next to you stares at something else entirely. (And yes, it tracks your head motion.)
Another approach, recently unveiled in a patent application, uses 360-degree projection that could turn your living room into a virtual environment. The television remains the central point of reference and the projector is used fill in peripheral details. Motion-tracking is used to enhance the simulation and keep the projector from sending light towards the user's eyes. The patent focuses on gaming, but it's not hard to imagine the same technology be used for virtual tours of distant locations or movies that provides 360 degrees of immersion.
Neither path is likely to become a consumer product soon--Stevie Bathiche, Microsoft's Director of Research in the Applied Sciences Group, wouldn't even hazard a guess about the consumer availability of the first example of holodeck technology--but both are promising ideas. Microsoft's combination of hardware and software expertise gives it a unique combination of knowledge that will be needed if virtual reality is to ever be practical and affordable for the average consumer.
Computers will need a tremendous increase in capability to render graphics on the scale envisioned by Microsoft's virtual reality research. The increase in resolution alone would increase the graphics power required by an order of magnitude. In other words, even if the other technologies required to create the company's holodeck were perfected tomorrow, it would still be a dream. Modern home computers simply couldn't handle it.
Microsoft's working on a solution, and it's based on the infirmities of the flesh. The human eye can only view a limited area in full detail. Our peripheral vision is much less sensitive. A computer with eye-tracking hardware--like, say, the holodeck mentioned above--can take advantage of this by determining where we're focused and rendering objects in the periphery with less detail, using an antialiasing algorithm to smooth out the lower resolutions found off-center.