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[Rodney Liuzzo]

Just as it had raised prices on its internet streaming customers, Netflix has lost a contract with one of its big content providers. The AP reports that Starz Entertainment, better known as a premium cable channel, announced it was walking away from a contract with Netflix that allowed it to stream Starz TV shows and movies over the internet.

The talks fell apart after the two sides disagreed over the value of the Starz content and how it should be sold to Netflix subscribers, according to people familiar with the negotiations. The people asked not to be identified because they weren't authorized to speak publicly.

In early trading, stock in Netflix was down up to 9.7 percent on the news. The loss is huge, says The Los Angeles Times, calling Starz Netflix's "most valuable source for movies." The Times reports the deal fell apart Thursday, after Starz demanded that Netflix customers pay more, if they wanted access to Starz content.

We believe the loss of Starz content could be disastrous for Netflix and has the potential to start the downward spiral, said Janney Montgomery Scott analyst Tony Wible expressed concern about Netflix's outlook. "A loss of subs could leave Netflix struggling to pay the over $2.4 billion in off balance sheet content obligations, especially when one considers that it is losing money on an adjusted free cash flow basis."

Barclays Capital analyst Anthony DiClemente is more bullish on the company. "We believe Netflix has a clear indication of what content is worth and the fact that it is willing to let Starz Play expire suggests to us the company is staying disciplined," he wrote in a report. "Netflix now has six months to redeploy its Starz...budget for incremental content and based on our discussions with studios, we do not believe that will be an issue." He maintained his "overweight" rating on Netflix's stock and his $285 target price.

Jonathan Friedland, the new vice president of global corporate communications who had joined Netflix just a few months earlier, asked whether customers on tight incomes might object to the price hike, according to people at Hastings' meeting. Hastings argued that Netflix was a great bargain. He said he knew that some customers would complain but that the number would be small and the anger would quickly fade.

Hastings was wrong. The price hike and the later, aborted attempt to spin off the company's DVD operations enraged Netflix customers. The company lost 800,000 subscribers, its stock price dropped 77 percent in four months, and management's reputation was battered. Hastings went from Fortune magazine's Businessperson of the Year to the target of Saturday Night Live satire.

To Hastings' credit, what he wanted to do made sense. The DVD's best days are behind it. Video streamed via the Internet is slowly replacing the physical disc, and betting a business on a dying product is never a great idea. So Hastings wanted to get ahead of the curve and focus on streaming, to disrupt his own business before someone else did it for him. It was aggressive, far-sighted, and very much in character.

Hastings is someone who knows a thing or two about disrupting businesses. Netflix, after all, is the company that drove the giants of video rental out of the sector with a simple premise: A simple-to-use Web site that delivers DVDs right to your doorstep. Best of all: No late fees. He became one of those executives with the "visionary" label, who can predict where a market is going before it happens, and was asked to join the board of directors of two of the most important companies in tech, Microsoft and Facebook.

Leading up to the first anniversary of the Netflix meltdown, CNET interviewed former and current Netflix employees to find out how a series of missteps turned into a lost year, and whether it has rebounded from those self-inflicted wounds. Most asked to remain anonymous. Netflix declined to comment for this story.

So how did Hastings stumble? Just prior to the attempt to remake Netflix into a streaming-video distributor, there was turmoil in the company's executive offices. Several of Hastings' most trusted lieutenants were no longer as influential with the CEO. Others had left and their replacements did not yet have the clout to convince Hastings he was being too aggressive for a customer base that by 2011 could hardly have been considered on the bleeding edge of consumer tech.

When customers and the press pushed back, the Netflix response was haphazard, culminating with an amateurish, confusing YouTube video heralding the coming of Qwikster, the spinoff that was supposed to be a life raft for Netflix's DVD operations. The Qwikster plan was scuttled three weeks after it was announced.

"Whatever happened to Fortune's Businessperson of the Year?" asks Wedbush research analyst Michael Pachter, referring to one of the many honors Hastings received in 2010. "Whatever happened to the guy who was invited to the boards at Facebook and Microsoft? What happened to that guy? Do you think Facebook would have invited him to their board now?"

Hastings has an unwavering belief that streaming video represented the future of home entertainment. He argued that in times of technological advancement companies that had succeeded at one business often clung too tightly to tradition and to what had made them successful. And then they were toast. He didn't want that to happen to Netflix. While few people disagree with that assessment, some within Netflix doubted Hastings' assessment of how quickly Netflix needed to shift to streaming.

But Hastings pressed ahead. Around March 2011, he took his plan to his executive team and then to the company's vice presidents. Some of the execs who heard Hastings talk about spinning off Netflix's DVD operations into a new company, referred to internally as DVD Co. and later Qwikster, left the meeting thinking Hastings was only considering the idea.

That impression was quickly corrected. Within about 72 hours, some of the group learned that Hastings had already offered the new company's CEO position to Andy Rendich, Netflix's respected chief service and operations officer. Hastings, it appeared, wasn't looking for debate.

Netflix rapidly began executing the plan. Some employees were stunned by how quickly and unemotionally DVD operations, the backbone of the business for a decade, was split off from the company. DVD Co. was moved out of Netflix's offices to a space a few blocks away. Netflix's leaders stopped discussing DVDs. Those Netflix executives who moved to DVD Co. stopped attending Netflix management meetings. Some of those people included Allison Hopkins, Netflix's vice president of human resources, Liz Coddington, vice president of financial planning and John Robison, vice president of DVD product development.

Few people who had worked for Netflix for any length of time were surprised that there wasn't more discussion about the plan. As Netflix's business blossomed and as he was personally applauded in the press, Hastings had grown much more confident in his own decision making, less receptive to taking advice from his senior management team. What's more, few of the people who could persuade Hastings or tell him he was making a mistake were around anymore.

Hastings co-founded Netflix in 1997 and eventually assembled a seasoned management team that he kept largely intact for a decade at the Los Gatos, Calif., company. The competition and long odds united them. In 2004, when the battle against industry heavyweight Blockbuster was at its fiercest, former CFO Barry McCarthy almost left. A 30-year veteran in finance, McCarthy decided to stay and joked with coworkers that "you don't walk out on friends in the middle of a knife fight."

After Hastings, the two most influential voices at the company were McCarthy and Leslie Kilgore, at the time Netflix's chief marketing officer. Smart, experienced and aggressive, they were the people who could challenge Hastings' ideas.

But in December 2010, after nearly 12 years at Netflix,McCarthy left the company following a conflict about his role and his compensation. For a while, McCarthy, who is now an executive adviser at venture capital firm Technology Crossover Ventures, chafed that Hastings refused to expand his responsibilities, sources said.

The large pay raise for Sarandos was indicative of how Netflix was evolving. The company was headed to a streaming-video future, and obtaining Web rights for movies and TV shows is tricky. Where once Netflix could obtain discs from a plethora of wholesalers and retailers -- even when Hollywood refused to supply the company with DVDs -- there were few ways around the studios when it came to streaming rights. Sarandos had the Hollywood relationships, and his solid gold Rolodex was very valuable to Netflix.

McCarthy was livid, said the sources, and he went to Hastings to discuss his salary. The two men worked on finding a compromise but the damage was done. McCarthy handed in his resignation and within two days Hastings replaced him with David Wells, Netflix's vice president of financial planning and analysis. The same day McCarthy cleared out.

That wasn't the end of the executive turnover at Netflix. Two months after McCarthy left, Ken Ross, head of worldwide communications since 2005, also resigned. In a 30-year-career, Ross had worked for such companies as Pepsi and Overture. Friedland, the man who replaced him, had a successful journalism career, rising to become chief of the Wall Street Journal's Los Angeles bureau, before moving into public relations. Still, when he took over for Ross, he had worked in PR for less than five years.

Ross' exit wasn't nearly as dramatic as McCarthy's. The previous September, when Netflix launched operations in Canada, the company was accused of hiring actors to appear at a press conference and dupe reporters into believing they were fans of the service. Netflix said the actors were hired for a separate promotion and denied they intended to deceive anyone. Ross had little to do with the situation, according to sources. They say the mistake was made by a junior person at an outside PR agency. Nonetheless, Hastings blamed Ross, who resigned in February 2011.

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