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The software on the development kits we have internally and that we give to our partners is a little different from the software you have on your console at home. It has a lot of code to help with debugging many components of the system. We also have the ability to use an Xbox-specific version of the kernel debugger you find on Windows.
Webuild the Xbox system software the same way much other software is built at Microsoft. A new version of the system software is built every day, which keeps turnaround time on bugs and issues down. We update the development environment we give to our development partners every month (the so-called Xbox Development Kit, or XDK). Finally, we update the software consumers' consoles have every once in a while, which is mostly determined by upcoming features, fixes to user issues, etc.
Unfortunately, a lot of the details of our software environment are under NDA, since things like XNA are a huge advantage for Microsoft. Post your questions in the comments and I'll see if I can answer them.
http://blogs.msdn.com/xboxteam/archive/2006/03/04/543751.aspx