Really awesome utility.
The key observation is that when performing updates, large runs of machine code will be identical, with only relative offsets and absolute addresses changing. Code changes tend to shift huge pieces of binary code in parallel (by the same offset), so the bytewise subtraction expresses these shifts as many repeats of the same bytewise difference, which is then more easily compressed by zlib DEFLATE (or maybe another compressor... I forget the details).
The flag will modify the storage format, -kinda packing files/chunk together instead of just compressing into a huge block- so that tools can detect diff and same sections over the full archive.
It's not well know but it is an absolute must known. e.g. for backup archive that goes over rsync, and change little over time.
I couldn't find the equivalent for 7z in a quick glance. It supports at least 5 compression algorithms so there is probably not a general option. Maybe one has to play with the advanced settings per algorithm, if they support it.
However, the resulting differences don't seem nearly as amenable to the bsdiff algorithm as the changes to the underlying uncompressed data. In almost all cases, you'll likely get better results with bsdiff on the uncompressed data (and bsdiff internally compresses its result).
Good deduplication and diff algorithms have adaptive block size detection.