Virtual Server and Virtual PC make use of VHD files, here is a link to a MS KB also the basic steps on making them smaller.
check ms kb note -
1. run defrag
2. Virtual Disk Precompactor tool The Virtual Disk Precompactor tool is available in Microsoft Virtual PC 2004 Service Pack 1 (SP1).
3. for virtual server virtual disk menu on the master screen selected inspect.
4. click compact vhd (virtual guest must be offline for this to run.)
I am going to attempt to script part or all of this.