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It seems the point of this fight is bidding when the company/government is already biased towards a specific vendor.

I have seen too many software vendors beat out the competition on an objective technical scale that I have taken a part in evaluating only to have Oracle win the entire contract with a sub par product and watching management skew the numbers into Oracle's favor so that their bosses remain happy. They'll spend more money for a lesser product simply because that is the status quo.

Does $560 per user for email in 2011 strike anyone as borderline ridiculous (minus the borderline part)?
The contract is probably for 3 or 5 years, so the yearly cost is probably around $110 - $190 per user per year. $190 would probably be a bit on the high side, but it depends on the technical and security requirements.
We did a similar proposal for university-wide e-mail last year, the bid is for a 3-5 year contract usually. You can take a look on Google's website and they will actually give you the per-user expected $ figure. There are several articles also which compare the two services (sorry just Google for them, I am about to go to bed), but the price is basically < $120 per user, per year.
The email part of it costs maybe a $1, if that. But throw in ridiculously high privacy, data protection, and access right standards (both for redundancy reasons, archiving, and privacy protections), and $500 sounds about right.
I just wish Google would have taken 508 compliance more seriously and thus gotten more government contracts in the past. They have only recently begin catching up to Microsoft on 508 compliance in their hosted e-mail solution. If they had done it sooner, more of the CSU system would be using Gmail instead of live@edu and OWA.
As much as I like seeing MS getting shafted, Google was pitching hosted email solution whereby they would run a "government only cloud". Telling them No was a very sensible thing to do. I'd rather have the government use an Exchange server than share its internal documents with Google. Apparently the govs are of a similar opinion which is quite telling.
Microsoft's solution was also cloud-hosted:

Microsoft, in an e-mailed statement, said Interior “determined that the dedicated, U.S.-based cloud solution offered by Microsoft met its minimum security and other requirements after a careful and thorough evaluation, and that Google’s solution did not.”

I could be totally wrong but I think the issue was that Microsoft was willing to host it (the private cloud) on-premise whereas Google wanted it in their data centers.
> d rather have the government use an Exchange server

Why do you hate your government so much? What have they done to hurt you so bad? Nobody deserves that.

Having e-mail on an Exchange server is something I would expect to be offered to Guantanamo detainees, if human rights watchers allowed that. It's soul-crushing. It's worse than waterboarding.

Hyperbole is OK, but please choose a torture method generally accepted as such, like being stretched on the rack or having your testicles fried in a frying pan. It will make your hyperbole stronger, and avoid contributing to the widespread notion that waterboarding is not "real" torture.
Well noted. I used waterboarding because that was one of the techniques being employed at Guantanamo, which is also mentioned in the post.

Having your e-mail in Exchange and having to use Outlook (or worse - Outlook Web Access) daily is indeed more like having the testicles fried in a frying pan or being stretched on the rack.