I've spent the better part of 4 hours trying to figure out how to fix this (also taking apart an xbox S-controller to look at the differences) and the fix isn't sanding alone. I'm pleased to say I've managed to make the d-pad tight as hell and it's improved my Tetris game considerably.
First things first, why it's not so hot: MS indadvertantly made two small changes from the old Xbox S-controller. 1: The distance between the button membrane (plyable plastic bit that hits the contacts on the circuit board) and the bottom of the d-pad's contact points seems to have shrunk very slightly (2mm?) so the pad can slide back and forth without pressing any buttons. Bad! 2: To fix this MS made the wall around the D-button thicker (just look at it).
These two problems come together in the following way: Sometimes, when you press a direction you can't get the membrane to connect because there isn't enough room in the well. This is where sanding comes in. You sand all the way around the outer part of the well so the d-pad can be moved enough to make contact but you're not done yet. But now the d-pad will slide around even more which is bad.
All we're going to do is add a very thin layer between the membrane and the bottom of the plastic of the d-pad to fill that space.
The end result is a directional pad that feels really snappy. I was surprised when I was finished with the first one how the controller actually clicks when you press in the direction you want. It feels completely different and 100% better.
(I originally posted this at cheapassgamer.com)
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Signing UpStep 1: Open and dissasemble the controller (security bits not required)
You need a Torx-9, but I didn't need a security bit to open the screws. Instead I inserted a small screwdriver and twisted until the security nub broke clean off (allowing the T-9 to fit perfectly).
The back sort of pops off from the top. Pull straight out, to avoid damaging the battery contacts that hang off the main board and slide into the controller back. Also, it helps to hold down the triggers.
Try to keep the controller face down when opening. This will keep the buttons from spilling out every where until you are ready for them.
With the back off, remove the main board -- I found applying light pressure to the analog pads helped. Notice the rumble motors are just sitting in the wells and are attached to the main board by jumpers. Leave them plugged in but move the board carefully (don't let them hang and stress the connection point).
Now, flip over the top and knock out all the buttons. Don't lose them! Also, don't worry, they are keyed, so they only fit in the correct holes and only fit so they are oriented the correct way.
Lastly, you need to get the D-Pad mechanism out. Unscrew the two small screws shown and gently apply pressure to each of the clips in the D-pad mechanism.





































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http://www.chinagreenelvis.com/brainsharts/death-to-the-d-pad.html
Hope this works for others, but not all 360 controllers are created equal.
It works great -- While the last thing the Internet needs is more anonymous anecdotal evidence, I have to say that this mod is FANTASTIC. It is so good, in fact, that the 360 controller will likely be replacing my sixaxis as my PC emulator pad.
Don't bother sanding -- I can confirm that the sanding part of the mod is wholly unnecessary. I sanded my first one, but neither the second nor third, and there is no functional distinction I could detect (and I am very particular about d-pads.) Nixing the sanding will cut your mod time by about 4/5.
Trace quarters for the spacer pads -- For creating correctly-sized spacer circles, if you have access to US currency, I highly suggest tracing around the outside edge of a quarter with an indelible marker, then cutting around the outside edge of the trace.
Try 1 or 2 sheets of plastic -- I have used two sources of plastic for the spacer: a pringles lid, and a plastic clamshell blister pack (you know, the kind that you need scissors to open, but you get halfway through and you try to rip it the rest of the way, and then it splinters and cuts your hand, and you start swearing.) The first controller worked fine with one layer of plastic, but the next two needed two layers for optimum springiness. Depending on your preferences, the plastic thickness, and your pads, either one or two layers might be right for you. Three layers was too many; the pad was so stiff there was basically no travel. You'd press it down and it would go almost nowhere, so it couldn't spring back up properly to give you that nice tactile response.
Re-tighten the controller carefully -- Make sure that when you put the controller back together, you screw it together tightly. If the backing of the d-pad isn't held snugly against the body of the case, you won't get appropriate tactile response. Be sure you aren't overzealous in your tightening; it can make the controller hard to disassemble, which presents a problem if you want to add or remove a plastic spacer.
The d-pad gets clicky -- Though the author noted this already, I feel that it bears repeating. After this mod, the d-pad will go from virtually silent to highly audible. Sliding your finger off the pad and letting it snap back up is about as loud as pulling one of the triggers down all the way and letting it snap back. Simply pressing one of the directions is roughly as loud as "clicking" down on one of the analog thumbsticks. I personally consider the auditory feedback a feature and not a bug, but for those of you who prefer silent d-padding, be warned.
See my istructables page here: Fix 360 d pad