A structured process for acquiring and analyzing an understanding of how users do their work.
In the beginning, there was Contextual inquiry, a field method (done in the field, as opposed to in the lab), which was a mongrel mix of ethnography, psychology, and software development pragmatics intended to allow designers to ground their domain knowledge in how real users really accomplished the tasks that the designers' product was supposed to support. The emphasis was on the interview, with some consideration for how to deal with the mass of raw data that was generated.
Over time, Contextual Design was developed as complete front end to the software development lifecycle, feeding directly into implementation. It is not clear to me what the boundry between Contextual inquiry and Contextual Design is. And I don't suppose it really matters - you use as much as you can or care to, given the constraints of the project on which you're working.
One of the problems with a number of HCI techniques is that they admit a lot of variability. The field is young enough that there are not established correct ways of doing things, and the situations in which they are employed so diverse that some variation is to be expected. So two people may claim to be using method X and yet be doing rather different things. Having said that, Contextual techniques, in all their variations, follow these three principles:
1. Context. You do your study in the context in which the work actually gets done. People often structure their environment in many ingeneous and subtle ways to help them do their tasks. If you take them out of this environment, they may forget or rationalize how they carry out their jobs. (I can't tell you how to get there, but I could take you there.)
2.Relationship with the user. This was originally couched as partnership, but later described as apprenticeship. The key here is that the user is the expert in how the job is actually done. You have to acknowledge that expertise, draw it out, analyze it, and understand the design implications of it.
3.Focus. Contextual techniques are not what you want to use for a fishing expedition. The idea is to get in, get what you need, and get on with the rest of the development cycle ASAP.