You have an absolute reference to the file in your KML file (C:\Users\Steve...). If image is inside your KMZ then you should reference the relative file location instead. Also, the file path C:... is not a valid URL which should be of the form http:// or file:// if using an absolute URL.
Let's assume the KMZ file has two entries (in this order):
- doc.kml
- IMG_20121025_163656.jpg
The IconStyle within the doc.kml should be rewritten like this:
<IconStyle>
<scale>1.1</scale>
<Icon>
<href>IMG_20121025_163656.jpg</href>
</Icon>
</IconStyle>