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)
Step 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.
Step 2: Sanding out the outer well
The picture of two controllers shows about how much sanding you should do by showing a before and after controller (look at the wall around the D-pad -- the top has already been sanded).
Don't worry about sanding too much, but do be careful not to remove anything from the inner circle or sand down. You're just sanding out and around. There are lots of tutorials and instructables about sanding, so I won't go into it too much here. I found it easier to carve out the space with a leatherman filing attachment and then go back in and sand with about 300 grit. Took me very little time. I also found it easier to move the controller while I kept the leatherman still, but whatever. This part isn't exactly a science.
Step 3: Creating the "gap" spacer
Get a pliable plastic top from a can of nuts (ideally clear) and trace the circle that's the size of the bottom of the d-pad.
Cut it out and punch a hole in the center that the pivot point on the bottom of the d-pad assembly can fit through.
Put the d-pad assembly back into the controller housing and then put our spacer on top of the assembly.
Put the d-pad membrane on top of the spacer (it'll be snug now).
Put the rest of the buttons and membranes back in and close up shop.
BE CAREFUL when tightening the screws. They strip *very* easily. A good trick for fixing a stripped screw is to put some of your larger sanding shavings into the hole with tweezers and then insert the screw.