Here is a video of a pickup being installed - it shows a good way to drill the hole. You really need to be careful - I have done a couple of these before with the wrong kind of drill and chipped a bit of wood away, rather spoiling the wood. The drills used here I think are called a step drill and a forstner drill, these can be bought on eBay or from hardare suppliers. I have seen an dendpin hole expanded with a reamer which seems to be a rather more expensive bit of kit. I think it may be a bit easier to create a new hole rather than expand an existing one. Anyway, good luck and hope this helps.
Don't worry about what goes on later in the video - it is a strange kind of transducer that needs a little channel routed out. Looks very complicated - I won't be trying that http://www.carlosjuan.eu/index.php?id=43