"ZIP" stands for "Zoning Improvement Code". It refers to the fact that ZIP codes were an expansion on a system of postal zones that were used in larger cities starting in 1943.
Decoding a zip code: The first digit designates a broad geographical area of the United States, ranging from zero for the Northeast to nine for the far West. The next two digits specify population concentrations within those areas. The last two digits designate small post offices or postal zones in larger zoned cities.
Thanks to Yahoo for reminding me that I am old;
Special recognition to ZipCode Man at http://www.zipcodeman.com/