"The term in-process component refers to an application that's running in the same memory space as the calling program. It makes the configuration of the IIS application very important. IIS allows an application to run in its own memory space, restricting application administration to the site level. For example, in prior versions of IIS, if a process ran amok, the possibility existed that the entire server might come crashing to a stop. Utilizing this feature, the administrator has the ability to stop the Web service just on the site and not on the entire server."
"Out-of-process components are COM components implemented as executables that launch as a separate process on the same computer as the client application. Out-of-process components are also called "local servers." Out-of-process components are different from out-of-process applications (also known as isolated processes). When you launch an out-of-process component on the Web server, IIS becomes the client application."
So basically, an in-process application runs as a part of IIS, is limited by IIS, and can be killed by stopping the IIS service.
An out-of-process application runs on it's own.
Again, from TechNet:
"Not all executables are safe to use on the server, and some may pose security risks. Also, because in-process component DLLs are faster, more secure, and can be hosted by Microsoft® Transaction Server (MTS), they are much better suited for server-side use.
Further, out-of-process components often create individual server processes for each object instance, reducing their performance to that of CGI applications. They simply do not scale as well as component DLLs that run in-process with IIS or MTS. If performance and scalability are priorities for your site, using out-of-process components is strongly discouraged. On the other hand, intranet sites that receive moderate to low traffic might be able to use an out-of-process component without adversely affecting the site's overall performance."
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