Jannik Sinner beats Novak Djokovic at ATP Finals
Sinner, 22, won a third-set tie-break to secure the group match 7-5 6-7 (5-7) 7-6 (7-2) in three hours and nine minutes.
It was 36-year-old Djokovic's first defeat since the Wimbledon men's final in July.
Earlier, Stefanos Tsitsipas withdrew from the competition through injury.
Tsitsipas, 25, retired through injury against Denmark's Holger Rune after consulting with a doctor at the changeover.
"It kills me not to be able to finish this tournament," the Greek said.
Sinner, who will play Rune in his third match, ended Djokovic's 19-match unbeaten run in front of his home crowd.
However, the 24-time Grand Slam champion can still qualify for the semi-finals by beating Polish ninth seed Hubert Hurkacz, Tsitsipas' replacement.
After Sinner took the first set, Djokovic levelled and fought back from 4-2 down in the third before being outplayed in the deciding tie-break.
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