I had a note to describe this setting in a future blog entry, but since I saw this question I figured I'd put this ahead of the other items on my to-blog list:

By default, when you send HTML mail and include pictures inline in the body, Outlook creates Mime-HTML or MHTML which is a message that includes both the HTML text as well as the inline pictures as part of the message. This of course does increase the size of the message.

Note: This is in regard to pictures displayed inline in the mail  - i.e. you can see the picture when you're reading the mail - not image files that are attached via Insert | File. While this might seem obvious to some, to Outlook Express users it could be confusing because OE has a feature whereby it displays image file attachments inline at the end of a message.

If you want Outlook to send a reference to the file (<img src="http://foo.bar/image.jpg">) instead of including it:

1. Tools | Options | Mail Format | Internet Format
2. Uncheck "When an HTML message contains &pictures located on the Internet, send a copy of the pictures instead of the reference to their location"
3. OK out of the dialogs

The next time you send a mail with an inline HTML image, Outlook will just include a reference to the image in the HTML rather than attaching it.

Note #1: This setting applies regardless of where the image exists - internet, local hard drive, intranet, fileshare, etc. So if you have a web page on your intranet and you right click on a picture on that page and copy it, and then paste that into an email, the recipient will receive a message with an HREF to that intranet site. If the recipient doesn't have access to your intranet, they will not be able to see the image. Similarly, if the image was copied from your local hard drive, a reference to C:\foo.jpg will be included.

Note #2: If the recipient is using OWA 2003 or Outlook 2003 and has content blocking enabled and you are not on their safe sender's list, they will not see the inline image until they click on the infobar and choose to enable it or add you to the safe sender's list. Trust me when I say, to channel Martha, "this is a good thing".

Note #3: To muddy the waters even further, when the above setting is unchecked, there are still some ways to get Outlook to include the image in the message, such as opening it in mspaint and copying it from there.

 

...Well, I hope this answers more questions than it raises. Let me know if not :-)