He will give you a clue (once you get onto the T'rang quests, I think it is the 2nd or 3rd T'rang quest). Crock also has something to do with this.If you just want the answer, highlight the following: "buy the eua de rapax perfume from Crock, use it on the dummy. Camp. Someone should show up. Optionally talk. Close the door, and squash."
You can also lure mosters in there and squash them, for effect, but you get no Exp pts for them that way.
Tools for Wizardry(r) 7
This dummy is used for a quest given to you by the T'Rang.Once you receive this quest, it should become clear what it is used for.
If you've already received this quest from the T'Rang and are still confused, let us know.
Spence