The correct message is the following "You have not configured ADO.NET Data Services to use V2 of the OData protocol. You can do that by setting the dscodegen_version environment variable to 2.0 and dscodegen_usedsc to 1."
I would also like to mention that we have been working on a whole new wizard for generating service called the "Generate OpenAccess Domain Model Service..." that you can find in the context menu of either an rlinq file or an Web Application in the solution explorer. You should give it a try.
I hope this helps.
the Telerik team