This distinction is largely a hangover left from the days where analogue video (and editing systems) ruled the roost. The distinction between online and offline editing was largely understood to mean the difference between a rough cut (or fine rough cut) and the finished version of a piece of video.
Two main factors drove the need to separate these processes: firstly, analogue video is not that robust a format, and tapes wear out incredibly quickly after rolling back and forth hundreds of times in a VTR. To prevent damage to the precious master tapes, copies were made and used to assemble and rough cut on lower grade equipment. Using the timecode from the copied tapes, an edit decision list (EDL) was produced containing the in and out points for each cut in the program. Once the EDL was complete, the editor would move to an online suite and use the EDL to prepare an “online” cut from the master tapes, this minimising the time the precious masters spent in the machines.
The second factor basically boiled down to cost. Higher grade equipment was inevitably more expensive to buy, and therefore more expensive to hire. Assembling a rough cut for any program is a time-consuming process, so any way to minimise the time in an expensive edit suite was desirable. Offline suites typically used cheaper equipment, which made them cheaper to hire.
Since the introduction of digital non-linear editing in the early 1990s, the line between online and offline editing has begun to blur (and will probably disappear completely sooner rather than later). In the early days of non-linear editing, the concept of an “online” edit suite was preserved by the cost of the computer hardware needed to manipulate digital video at lower levels of compression. But thanks to Moore’s Law, this barrier has begun to disappear and with it, the need to differentiate offline from online editing. High-end desktop computers are now powerful enough to edit uncompressed digital video and the cost of the software and additional hardware to drive them has also come way down.
Although considerably lower than 10 years ago, the cost of hardware (and indeed the business models which drive the vendors of non-linear editing systems) still means that high-end equipment is expensive to buy/hire and therefore perpetuates the online/offline division for the time being. Systems from Avid (such as Media Composer, DS Nitris, and Symphony) and Discreet (Flame, Smoke, Inferno) still dominate the online finishing needs for many professional productions, but the reality is that you can create an online edit in most pro/semi-pro packages these days. Much of the power and functionality of these high-end systems has found its way into more accessible products such as Apple Final Cut Pro or Avid Xpress Pro (particularly the newer “HD” versions), and certainly for the average independent filmmaker, marks an quantum leap forward in terms of the tools available (and the distinction between online and offline largely moot).