Set smooth shading in the toolbox.

Using set smooth shading in the toolbox I can make very low poly meshes look highpoly.

Sometimes it takes 2-4 subsurfs to come up with the same amount of smoothness as using the original model and using set smooth in the (T)oolbox.

What does this option really do? and is it ok to use this on multiple objects rather than subsurf.

Heres an example:

(This is the same model duplicated, one with smooth, one with flat in the SS.
Actual face count of 1 body and hair is 1021.)

Very lowpoly mesh made nice with set smooth. Is this costly? or the efficient way? Rahter than using subsurf.

Smooth shading is not only efficient enough (flat shading is slightly easier to compute), it is the most common shading technique used in games. In other words, use it. You can take it a bit further by using the edge split modifier to create smoothing groups.

As Kupoman mentioned, it influences the shading, not the geometry.