A rainbow table is "just" a smart compression method for a big table of precomputed hashes. The idea is that the table can "invert" a hash output if and only if a corresponding input was considered during the table construction.
Each table line ("chain") is a sequence of hash function invocations. The trick is that each input is computed deterministically from the previous output in the chain, so that:
- by storing the starting and ending points of the chain, you "morally" store the complete chain, which you can rebuild at will (this is where a rainbow table can be viewed as a compression method);
- you can start the chain rebuilding from a hash function output.
The reduction function is the glue which turns a hash function output into an appropriate input (for instance a character string which looks like a genuine password, consisting only of printable characters). Its role is mostly to be able to generate possible hash inputs with more or less uniform probability, given random data to work with (and the hash output will be acceptably random). The reduction function needs not have any specific structure, in particular with regards to how the hash function itself works; the reduction function must just allow keeping on building the chain without creating too many spurious collisions.