Installing the Upgrade media for Windows 7 means you need to do a "custom" install, but that very quickly gets you into catch-22 like problems if you try to upgrade your existing XP virtual machine. Windows 7 install will ask for SCSI drivers and your partition may be the wrong size. Simply creating a new machine under VM Fusion works until Windows 7 Install can't find an existing qualifying installation.
Solution:
1. Create a new Windows 7 machine under VM Fusion WITHOUT any media nor easy install. Be sure to select Windows 7 or Window 7 64 bit as the VM type depending on the type of Windows 7 install you are doing.
2. Shut down that new virtual machine
3. Add the virtual disc of your old XP VM to the new VM. Set it as a SHARED disk.
4. Set the new VM to start up from CD
5. Start up the new VM from CD using your Windows Upgrade media. Windows media will find the old install and allow you to install onto your new VM's drive. Be sure to select the correct drive!
This also takes care of the SCSI drivers issue for both Windows 7 32 and 64 bit because step 1, creating the new VM, lets Fusion add the right SCSI drive support for the Windows Version.
6. After installation, shut down your new Windows 7 VM and remove the XP drive from, but KEEP the file.