While this is a really good option for keeping your iPhoto library at a manageable size, there are some significant limitations.
When you untick the option to copy items to the iPhoto library, iPhoto only has one method for managing the location of those files. An alias. The problem with this is that if you ever MOVE the original files from one hard drive to another or lets say you take a folder with you on a laptop, iPhoto will not know where those files are located.
How do you fix this? By telling iPhoto where each file is, one at a time, through a modal dialog box. That's right, one at a time. I've done this with a library of over 2000 photos... not fun.
So, I switched to Aperture. It allows you to store files in separate locations and what's even better, you can move them. Then tell Aperture where to look for the files (one time!) and it will relink them all automatically.
iPhoto use to be a great tool for basic editing and library management. As my library of digital photos has grown (who's hasn't), it was time to move to a real tool for not only editing photos but for managing an 80GB library without limitations.
BTW - Aperture can read and import photos from iPhoto as well as make edits between the two in case you need to use iPhoto for whatever reason. Any update to a photo made in either tool will sync up in both libraries.
Pardon me for jumping in here but I'm a new convert. Bought my Macbook last weekend.
I wasn't to keen on the all inclusive "package" deal either. I went into preferences/advanced and UNticked the box "Copy items to the iPhoto Library".
My folder structure that I'm used to working with is retained (outside the Library package file) and the Library package itslef doesn't bloat. The originals folder in the package just has shortcuts (or is that alias now?) to the original files.
Maybe I'm missing the point...