In the past you could have a situation where the avatar would appear as a cloud or totally grey due to the viewer not being able to get all the information it needs to fully render the avatar. Server side baking does the hard work at the server end making it easier for the viewer to display the world.
Its imperative so not to have avatars looking grey or broken in some way that you are using a viewer that supports the new server side code. The official viewer and many 3rd party ones have already updated to support the new system, but some older viewers like phoenix have not and if you want to view the SL world properly you will need to be on an updated one.
The video below explains more about project sunshine.
Story Source: http://community.secondlife.com/t5/Featured-News/Project-Sunshine-Goes-Grid-Wide/ba-p/2148427