I've made this change on a number of occasions, so I'm linking this here to hopefully save myself and / or someone else some time in setting this up.

Credit to Paul Bouwer for his blog post Replace diff/merge tool in Visual Studio Team System with WinMerge ( https://blog.paulbouwer.com/2010/01/31/replace-diffmerge-tool-in-visual-studio-team-system-with-winmerge/ ).

In short:
Tools -> Options -> Source Control -> VSTFS -> Config User Tools
Merge: /e /u /wl /dl %6 /dr %7 %1 %2 %4
Compare: /e /u /wl /dl %6 /dr %7 %1 %2

And for, in my opinion, a better formula than the one described in the article, check out Kashiraja's comment.