when it says you need an update is the xbox signed into live at the time, if so it should ask you if you want to download it.
i know if you put a divx movie on a memory stick and plug it into the xbox it will prompt you to download the update for that as long as you are signed into live.
as far as i know the xbox only plays avi (divx) or wmv videos when linked to media centre, vob dvd files wont play, they would first need to be converted to a supported format.
heres a bit more info on exactly what the xbox supports
http://blogs.msdn.com/xboxteam/archive/200...ayback-faq.aspx