A subdomain looks like this: ducks.birdies.com
Consider subdomains only if your site is enormous (thousands of pages) and you have the time to build links for the subdomain, as it will be considered a separate site by search engines.
Subdomains, if grown with content and outside links, as if they were separate sites, can link to and increase the rankings of your primary domain.
So why use subdomains instead of just buying a whole new url? For one thing you might want to increase brand recognition between your subdomain and your primary domain. Your subdomain will carry the brand value you’ve developed for your url.
Here’s an example given by Rob Sullivan on when he used subdomains:
I recently consulted with a large legal website and they felt that they weren’t getting the traffic or exposure they should. Upon my analysis, I determined that this site, while organized into subfolders, was actually causing itself harm in the search engines. This is because there was so much information available on the site on a variety of topics that the engines were having problems categorizing it.So we devised a subdomain strategy that would help focus certain areas of the site to help them compete individually with their competitors.
Hot topics such as Bankrupcty and Divorce became their own subdomains because a) there was sufficient content (tens of thousands to hundreds of thousands of pages) to support the subdomains and b) because they are highly searched for topics.
Through this strategy they created various subdomains and then used the .htaccess 301 rewrite rules to make it appear that the content had moved.
A subfolder looks like this: birdies.com/ducks
The vast majority of site builders will be better off sticking with subfolders for organizing their content.
How you organize your site and name your subfolders of course is part of your overall SEM strategy.
Rand Fishkin says it well in his Beginners Guide to SEM:
The URL of a document should ideally be as descriptive and brief as possible. If, for example, your site’s structure has several levels of files and navigation, the URL should reflect this with folders and subfolders. Individual pages’ URLs should also be descriptive without being overly lengthy, so that a visitor who sees only the URL could have a good idea of what to expect on the page.
If you’re new at SEM marketing, or if your site has fewer than 10,000 pages then the chances are good that you’ll find little SEM benefit from subdomains and should instead concentrate on lining up your site’s structure and its folder-names with your overall site keyword strategy.
More subfolder vs. subdomain resources:
URL and Subfolder strategy (from Rand Fishkin)
Question :: Are Subdomains better than Subdirectories? (from Rob Sullivan)
Subdomains – What are the SEO benefits? (from Joe Balestrino)
Subdomains versus subdirectories (Webmaster World thread)
Will Subdomains Help With SEO? (Search Engine Watch thread)