Dell doesn't WANT you to upgrade! Doesn't that make sense? It's the same with big box companies all the time mate! That's why it's only backwards compatible (typically).
The fx1600M however, DOES WORK for sure, I installed one into my friends e1705, and yes, it does work. It's not better than a 7950 gtx though.
I know, for dx10 support, we were getting lower scores and higher temps than with the 7950, I think it's cause it's limited by it's 128 bus while the 7950's got the whole 256.
The 3600M even works apparently, there just isn't bios control, and it downclocks a lot, and the brightness fails for control, so it's just feasible or practical, there's a whole thread on that.
If you do decide to do any upgrading make sure you have your cooling and power requirements in order first, and the highest you can go with dx9 is a 3500fx, and dx10 1600fx.
I wish we had people that could mod the bioses for us, and force flashing isn't an option because of the damn program dell uses for flashing the bios. I have yet to find a standalone program like nvflash for dell bioses where you can just pick one to force flash.