I use the 7D primarily for wildlife photography, and most of that would qualify as "action" photography---lots of birds in flight, for example.
Your picture is not at all bad! I second a lot of what's been said, and I'd emphasize a faster shutter speed (that's key) and turning off expansion---using just the center AF point. (The latter will irritate some people, but it's what works for me. Try to get better at aiming with your lens and take as much control as possible away from your camera, which, after all, can't tell the difference between a dog and a brick.) The slower servo will help too, but I don't think that was a factor here.
The other trick to getting good action shots is, frankly, "spray and pray." Get the exposure right, set your camera to continuous burst, hi-speed, keep AF on servo and just hold the button down, taking as many shots as you can of the action in question. (The 7D has a good buffer, so you should be able to get a bunch.) This will dramatically increase the odds of you getting at least one shot that's sharp. (Even the pros will tell you they get far more bad than good---it's the nature of the game.) No film being wasted, so why not shoot away?
As for aperture (DoF), there's no hard-and-fast rule here. I use the 400 5.6L, which is sharp wide open at f/5.6, and I tend to keep it there, occasionally stopping to f/8 if the light is really really good. 5.6 isn't that shallow, really, and while it's true that a tighter aperture would be a bit more forgiving when it comes to depth and focus, I personally prefer to keep the aperture as wide as possible and avoid having to bump the ISO (causing grainier pics). If I had, say, the 400 f/2.8 (someday!), I might consider stopping down to 5.6 for closer subjects where I'd be afraid the DoF would be too shallow, but with a lens using a 5.6 maximum ap, I don't think there's really any need to stop down--unless the lens is noticeably sharper at, say, f/8. Again, a fast shutter speed and good focusing technique are the most important things!