A grid of 8000 grid boxes of equal area is used. Time series are changed to series of anomalies. For each grid box, the stations within that grid box and also any station within 1200km of the center of that box are combined using the reference station method.
The largest change comes during the mid-20th Century, for example due to an adjustment to account for the sources of SST data switching during World War II from European fleets to almost exclusively US fleets (discussed by Schmidt at the link above). These adjustments, which somewhat dampen the mid-century cooling, are quite apparent in Figure 3, which takes the difference between HadCRUT4 and HadCRUT3.
2.1 LT Calculation
We have fundamentally changed the calculation of the lower tropospheric temperature product, LT, from a multi-angle method to a multi-channel method.