CustomPress Plugin: Trying to understand the relationship between Custom Post Types and Taxonomies

Hello,

I am trying to set up "Services" and "Products" using the CustomPress plugin. An example would be:

-Merchandise
--Custom Embroidery
---Armbands
---Patches

When using CustomPress, how can I make one level subordinate to the other? Is this what Taxonomies are for? Or should I use categories to accomplish this?

I do admit... I'm kind of confused about the relationship of "Custom Post" and "Taxonomy"... but then again, initially it took me a while to understand the difference between a page and post...

Thanks in advance for your help!