(from the Hardware vs. Software department)
I'm posting this information in my blog because there's been a lot of churn on these facts, and I need to document all of this information with as much real data as possible, before it gets lost. Most people will find this pretty esoteric, but if you want to see how global companies operate, read on!
The Sony Playstation 3 (PS3) is backwards compatible with the PlayStation 2 (PS2) and PlayStation (PS1). However, Sony has developed two different ways of doing backwards compatibility using either a hardware or a software solution.
Originally, the PS3 was to use pure software emulation via its powerful Cell microprocessor for PS2 and PS1 backwards compatibility. It is theorized that PS1 titles still may only utilize software emulation, based on this original development decision. However, sometime during the development process, this plan was partially abandoned in favor of a hardware solution for PS2 compatibility.
Therefore, at their November 2006 launch, the original North American and Japanese 20 gig and 60 gig PS3s had a custom PS2 Emotion Engine (EE) + Graphics Synthesizer (GS) chip on their motherboards for backwards compatibility. This custom EE+GS chip was later replaced on the European and Korean models with a single PS2 GS chip in a motherboard revision before their respective product launches, due to the increased performance of the EE software emulator, and to save money on the manufacturing costs. Interestingly, the two different motherboard revisions are apparently not interchangeable - the hardware units can't be "switched off" to become software units.
Since these models relied on software EE emulation, and this type of emulation is quite complex, the percentage of compatible PS2 games were lower for these machines at launch. Each successive System Software revision, however, has seen continual improvement in PS2 backwards compatibility percentages for these hybrid software emulation PS3s. Direct comparisons between the two different designs were initially hard to quantify, since there was only one motherboard design released in a region, and games differ too much between these regions.
The software emulator's difficulties with PS2 backwards compatibility was not a big issue for North American users since all models sold since launch, including the almost immediately discontinued 20 gig model, had the EE in hardware on the motherboard. This situation would soon change when Sony dropped the price of the 60 gig PS3 to $499 in North America and introduced a new 80 gig model at $599. Early press reports revealed that the 80 gig model would be using the EE-less motherboard, and therefore would rely on software emulation for PS2 compatibility. It also was quickly revealed that the 60 gig model was being price reduced because it was being phased out. Sony stated that they would only offer the 60 gig model until stocks ran out.
Sony recently started offering an on-line service for checking compatibility between the North American EE 60 gig models (including the discontinued 20 gig) and the non-EE 80 gig models. Curmudgeon Gamer has recently gone through their game library with this web service, and posted some interesting results. In their findings, the PS1 compatibility results are identical, lending some credence to the theory that the PS3 uses pure software emulation for PS1 titles. However, the PS2 compatibility results are quite different, with the hardware EE 60 gig model seemingly much more backwards compatible.
In summary, if backwards compatibility is important, it might be a good idea to pick up one of the 60 gig PS3s before stocks run out. PS1 compatibility appears identical between the two revisions, but PS2 compatibility seems to benefit from having the EE present, as in the 60 gig model.
UPDATE: added additional hardware GS information, per recent Sony documentation.