Effectively, it refers to how well your "brewery" (or in most cases, your brewing setup) converts grain starch into sugar. As such, it doesn't apply to extracts, since they have already been converted.
Higher efficiency allows you to use less grain for more beer, basically. However, it's worth noting that in a very generalized sense, as the OG of your recipe goes up, your efficiency is likely to go down, particularly with beers that use a lot of varied or specialty grains.