Collocation means "co-location". Collocated hosting lets you place your own web server on the premises (locations) of a service provider.
This is pretty much the same as running your own server in your own office, only that it is located at a place better designed for it.
Most likely an ISP will have dedicated resources like high-security against fire and vandalism, regulated backup power, dedicated Internet connections and more.
Good:
High bandwidth.
High up-time.
High security.
Unlimited software options.
Bad:
Expensive.
Requires higher skills.
Harder to configure and debug.