The update adds a dedicated 'blade' for Xbox Live Marketplace, cross-platform integration with Windows Live Messenger, improved VGA performance, and support for H.264 and MPEG-4 codecs.
If you're using your Xbox online, you'll have to download it or be booted off.
Interestingly, Microsoft has used the update to jump on the eco-friendly bandwagon. If you're downloading a large game or demo from the Marketplace, the console will effectively switch itself into 'low-power' mode, where almost everything besides the net connection and the hard disk are inactive, enabling you to download overnight with the minimal power requirement. The console will even switch itself off when it's done.
Saving the world one Xbox at a time. µ