I think this got me at first too - because it doesn't work by default :( You need to go into Setup on the DVD player, pick Audio Setup, and change 'Dolby Digital' from 'D-PCM' to 'Dolby Digital'. This is allegedly to protect people who are using a digital connection without a DD decoder from getting a bunch of nasty noise.

Otherwise, make sure the receiver is in the proper input mode (it should say 'optical' on the display). If not, change it with the 'input mode' button. Also, I don't think that this is necessary, but set the sound field on the receiver to 'Auto Format Decode' or one of the Cinema modes. As long as you do that, the receiver should decode a DD signal if present, it will display 'Dolby Digital #/#' for a few seconds when it detects the signal and the blue light will come on.

On the DVD player, I don't think the blue light being on necessarily implies that it is sending DD out; only that DD is present on the DVD or is being read. i.e. it could still be on even if it's downmixing (D-PCM setting).

The only other thing I can think of is that some (mainly older) DVDs select the stereo track by default instead of DD, if this is the case and the DVD has a DD track, cycle through with 'Audio' until you find it.