Dev7 does NOT create patches correctly if you compressed the files in Release Wizard.
1) When you go to make a build, make two Product Configurations: one compressed (which, if you're like me, you release to customers) and one uncompressed
2) When you go to make a patch, ONLY POINT TO THE UNCOMPRESSED VERSIONS.
3) The patch that's then generated seems to also work just fine for updating your compressed versions.
I haven't tested all this thoroughly. Wanted to get this breakthrough up so others could start helping me knock this problem out.
P.S. Still haven't figured this out. If user tries to update their install with a newer FULL release (not a patch), is it supposed to work? I've had no luck so far on this latter scenario.