You pick an artist, and the Smart DJ will make a Playlist with artists that sound similar to the one you chose.
I have a The Devil Wears Prada Smart DJ, and the playlist it chose consists of Norma Jean, As I lay Dying, etc.
If you choose Smart DJ on the Quickplay tab it will only make a playlist of songs from your collection.
But of you go to the Marketplace and choose Smart DJ on, let's say, a Pearl Jam album. It will make a playlist from anything in the Marketplace, that is, if you have a Zune Pass.
Hope I was clear enough lol.