I tried a similar upgrade route from an old version of 2000 SBE to an Office XP upgrade - mostly because of the cost difference between the full product and the upgrade.
Once it detects a valid upgradable product is installed on your machine it lets you install, once the install is done it asks if you want to activate the product or skip it for now.
You can choose to keep on skipping for up to 60 days (from install date?), after this it ceases to work unless you you activate it.
Activation can be can be completed one of two ways (there may be more ways but there were the obvious ones - precise details about activation were very scarse in the documentation);
Over the internet - you key in the various codes etc and press go, a few seconds later it says thanks and you are done.
Over the phone - you key in the codes over the phone, it takes an age and then finally it tells you what you need to enter on your machine to activate.
Personally I tried the phone approach but it was irritating enough to really deter me so I just did the internet registration.
I did try skipping for a while but it's kind of like using shareware which comes with a nag screen - every time you start an office product it "reminds" you to activate before eventually letting you skip.
IMO the price of Office XP compared to the features it offers isn't really worth it - especially when you could pick up an office 2000 profession or above for peanuts which has pretty much all the basic features of office XP with the added bonus of no activation!