Ross Burton's Vendor Branches in Subversion is a decent explanation of how vendor branching works.
CodeGobbler has an article on SVN repository structure for Drupal projects that includes using svn:externals for modules.

Adding a Vendor branch to your repo
Check out a copy of the entire repo from the very top level:

Create a vendor folder in the top-level:

Within that folder, create folders for modules and themes:

Commit your changes back to the repository:

Delete the checked-out copy:

Installing a module
Check out a temporary copy of your vendor folder:

For this example, we'll use the Content Construction Kit (CCK) module. Firstly, we'll create a folder that will hold anything related to that module:

Within that folder, create a directorythat will hold the "current" version of the module:

Commit the folder changes:

Download and untar copy of the module. For this example, we're going to download the outdated 5.x-1.6-1 version so that afterwards, we can demonstrate how to update a module.

Normally, when you untar a Drupal module, the resulting directory name doesn't contain the version number. However, in our case we're going to want it to contain that detail:

Load the module into current:

Install the module to your site
Navigate to where you want to add the module (sites/all/modules or sites/sitename/modules). If the folder doesn't exist, create it. Eg:

Copy the module to the checked out site:

Upgrading the module
Download the new module version:

Load the new version into current:

Merge the new current version of the module with your working copy in trunk. Using merge instead of copy in case you've made any changes to the version in trunk.

Commit the update into your repo: