When you deploy a Web site, you often want some settings in the deployed application's Web.config file to be different from the development Web.config file. For example, you might want to disable debug options and change connection strings so that they point to different databases. Starting from Visual Studio 2010, ASP.NET provides tools that automate the process of changing (transforming) Web.config files when they are deployed. For each environment that you want to deploy to, you create a transform file that specifies only the differences between the original Web.config file and the deployed Web.config file for that environment.
A transform file is an XML file that specifies how the Web.config file should be changed when it is deployed. Transformation actions are specified by using XML attributes that are defined in the XML-Document-Transform namespace, which is mapped to the xdt prefix. The XML-Document-Transform namespace defines two attributes: Locator and Transform. The Locator attribute specifies the Web.config element or set of elements that you want to change in some way. The Transform attribute specifies what you want to do to the elements that the Locator attribute finds.
More information about creating a transformation file here and about the syntax here.
Last week I discovered the Web.config Transformation Tester, a simple web tool that allows you to test your transformations in a very easy way. It allows you to paste your web.config into the top text box and your transform into the second one. Click the 'Transform' button to see the result of the transformation.