Let's see... Images obtained from the BD-ROM (a digital source) are best output in their digital form: that is, through an HDMI cable. Outputing by component cables convert the image to analogue via DAC, meaning a decrease in quality (which *should* be inperceptible). PS3 and Xbox 360's DACs are supposedly not the best in the market.
But do consider the fact that liquid cristal and plasma panels are digital. This means that an analogue source must be converted to digital... Re-converted unecesarily, considering the source was digital in the first place! If your TV's analogue-to-digital converter is weak, expect a drop in image quality.
In short, outputting by HDMI by-passes two potentialy degrading conversions.
Still, some people prefer analogue outputs because they see a "warmer" picture; some dismiss HDMI images as being too "digital" and "pixelated". It's up to personal taste, in a way.
Regarding upscaling: upscaling should improve perceptual quality. Absolute quality, however, decreases.