As described in my 8.10.2011 blog post, when you install or upgrade to Lion, a 650MB hidden partition is created on your boot volume named Recovery HD. You can boot from this volume by holding down command-R at startup, and it can be used to repair or reinstall Lion. Basically this replaces the functionality of the OS X install DVD, which is not available with Lion.
This Recovery HD partition may however be missing if your Lion boot volume was restored from a clone, if your Lion boot volume is part of a RAID, if your Lion boot volume has become corrupt, or if the boot volume previously was partitioned into multiple volumes prior to installing Lion.
To address the possibility of a missing Recovery HD partition, OS X 10.7 has a redundant feature called Lion Internet Recovery. If you boot into Lion while holding down command-R, and a Recovery HD partition isn’t found, the Lion Internet Recovery will attempt to boot via the internet directly from Apple’s servers. This feature requires that the Mac is connected to the internet using DHCP (you will be prompted for a Wi-Fi password if an Ethernet connection isn’t found), and only works on newer Macs.
All Macs that shipped with Lion pre-installed support the Lion Internet Recovery feature. Macs manufactured after mid 2010 are also supported, but require a firmware update to activate this feature. See here for a list of supported Macs and firmware updates: http://support.apple.com/kb/HT4904
The Lion Internet Recovery feature will run a quick test of your memory and hard drive prior to giving you the ability to repair or reinstall Lion. If you have to reinstall Lion, it will be downloaded via the internet (just like booting from the hidden Recovery HD partition does).