There's like a $10/mo discount buying the phone then bringing it to VZ to use. At a $600 difference in price (vs. $99 on contract), you can't make the difference up with a $240 reduction in service cost.
So yeah, technically you're right, it's $99 with a 2 year contract, the problem is that people do know what these devices actually cost. Hell, you can look them up on Amazon and ebay while you're in the store and the sales reps will even help you do it. It's just not always cheaper to roll your own.
The problem with Amazon's phone is that when you go phone shopping you just don't see one in the phone stores. If they can only be bought off contract, your effective price for the phone is still north of $400, at least on Verizon. Not even the latest iPhone or Galaxy <whatever> sells in that price range on contract.
But it's worse than that. Many Americans are such complete consumers that they'll pick the higher-priced item solely because it has a higher price, "reasoning" that, if it has a higher price, then it must have a higher value.
App stores and the rush to freemium with IAPs are a counter to your point.
Which, along with similar comments I see on nearly every US-focused tech site, leads me to conclude that basically no-one in the US knows how much phones cost, not even literate techies of the kind that hang out on HN.
My best guess as to why Amazon thought they could sell a ho-hum phone for $650 dollars is therefore: to a large degree no-one in the US knows or cares how much their phone costs so reducing the price has little to no impact on sales.