What does --prefix do exactly when used in ./configure?

When you install software with make install or sudo make install, different files are placed in different directories. Executables that provide commands the user is intended to run usually go in a bin directory, libraries usually go in a lib directory, manual pages usually go in a man directory, and so forth.

When you run ./configure, the --prefix option lets you specify where those directories are. It is called --prefix because it lets you give the prefix that appears in the paths to each of the directories where files from the program or library that you are building are to be installed. Most configure scripts support --prefix, and omitting it and just running ./configure is typically equivalent to ./configure --prefix=/usr/local.

To answer this more fully, I've reproduced two sections from my answer to How to install tar file “globally”? (on Unix & Linux), which address this question specifically:

Configuring Your Build

When you have source code that is compiled by running ./configure and make, you will usually use make install (or sudo make install) to install it. This copies files from the build directory into the install location. When the thing you are installing provides executable commands, those executables are typically copied into a directory that is in $PATH or that you should consider adding to $PATH.

Although building and installing software is often as simple as running ./configure, make, sometimes make check or make test, and then make install or sudo make install, you will sometimes want to pass options to the configure script to configure the build. In particular, as pfnuesel says, this is how you configure where the software is going to be installed. Even though the make install step actually installs the software, the locations where everything will be installed are typically established in the ./configure step.

The most common option for this is --prefix. The default prefix, when you don't tell configure what to use, is usually /usr/local. (Occasionally, a program or library's source code defaults to some other prefix. Fortunately this is rare.)

So ./configure is usually equivalent to ./configure --prefix=/usr/local. To install software in your home directory, you could use ./configure --prefix=/home/galahad (if /home/galahad is your home directory) or --prefix="$HOME". Then of course you must still build and install the software with make. I should say that not all software that is distributed in source code form is built this way. You should always look for documentation inside the extracted source code archive.

What --prefix Means

When you run ./configure --prefix=directory, you are indicating that the software should be installed under the directory directory. But this rarely, if ever, places loose files in directory. Instead, it places files that serve different purposes in the different subdirectories of directory. If those subdirectories don't exist, it creates them.

Executables usually go in directory/bin, though they may go in directory/sbin if they're commonly used for system administration or they may go (more rarely, these days) in directory/games if they are games. Libraries go in directory/lib or another similarly named directory like directory/lib32. Header files go in directory/include. Manual pages go in directory/man. Data files used by the software go in directory/share.

That's what it means for directory to be a prefix. It's the parent directory that contains the locations in which different files will be installed. It thus appears as a prefix in the absolute paths of most files and directories created by running make install or sudo make install.

There are some exceptions to this. Systemwide configuration files--which are sometimes created when installing the software that will use them, though not always--usually go in /etc. This is not typically affected by specifying a different prefix. Even if you install a lot of software in /usr/local, it will still mostly use /etc, and your /usr/local/etc directory will probably be nonexistent, empty, or contain very few files.

On many systems, you can find more information about typical filesystem layout by running man hier. If you're using a GNU/Linux system you may be interested in the Filesystem Hierarchy Standard.

It tells the location of the things which are required to configure the current package or software.

Like in a simple case, it can tell the location of ssl libraries:

--with-libssh2=/usr/local  #used in configuring nagios

and it also tells which packages not to configure, to make suitable compilations of the program according to your system:

--disable-shared  # used in configuring nagios
--disable-link-balancer  # used in configuring Firehol

These are just extra options to make a compilation suitable for your system. It is what I think. Do correct me if it is something else.

The --prefix=PREFIX option installs architecture independent files in PREFIX. When you run a make installcommand, libraries will be placed in the PREFIX/lib directory, executables in the PREFIX/bin directory and so on.

If this argument is not passed to the configure command then the default value is /usr/local.