There are purchased items on your iPhone that have not been transferred ...
"There are purchased items on the iPhone that have not been transferred to your iTunes library. You should transfer these items to your iTunes library before updating this iPhone. Are you sure you want to continue?
From iTunes, I have done a right click on the iPhone device and run "Transfer purchases" and "Backup". Running sync implies that it will erase my content on the iPhone so I am not sure what to do with that. What more do I need to do before I can install the OS Update?
iPhone 3GS, Windows 7, iTunes 10.