The 18-times grand slam winner won only nine points in the opening set as her game deserted her in alarming fashion.
The double defending champion, who was on a 16-match winning streak in the event, served seven double faults and struggled for any rhythm with her groundstrokes as the world number four claimed a famous first win over the 33-year-old American.
Williams can still make it through to the semi-finals of the season ending event but she will need to beat Canadian Eugenie Bouchard on Thursday.
(Reporting by Patrick Johnston; editing by Sudipto Ganguly)
