Over the course of 67 minutes at The O2 arena, Thiem racked up 34 unforced errors in a 6-2, 6-3 defeat.
Meanwhile, world No. 1 Novak Djokovic edged closer to securing a place in the last four of the ATP Finals after defeating Germany's Alexander Zverev 6-4, 6-1 yesterday.
However, the 20-time grand slam champion still needs to beat the in-form Kevin Anderson, who knocked him out at Wimbledon and who dropped just one game against Nishikori in Tuesday afternoon's match, if he is to clamber out of the group. "So I'm very happy that that was the right decision and I was able to show a reaction from my first-round match".
The 37-year-old's proud record of always reaching the semi-finals at the season-ender since it moved to London in 2009 looked in peril after a surprise loss to Kei Nishikori in his opening round-robin match on Sunday.
Whereas he struggled for timing and was a little grumpy on Monday against Nishikori, Federer found his groove from the start against Thiem as he hunted an early break.
Roger Federer has hit back at claims he gets "preferential treatment" from tennis tournaments due to his status as one of the sport's all-time greats.
The French veteran felt Federer's reputation meant he was granted his preference to play in the evening session to avoid the blistering Melbourne heat and offered the Swiss' matches at the last two Australian Opens as evidence.
"So for me, it was really important to remind myself what a thrill it is to play here at the O2".
The 32-year-old won the first 11 games against Nishikori before his relieved opponent finally got on the scoreboard with an angled victor.
The 28-year-old leads their head-to-head 3-1 and thumped him 6-3 6-1 in Vienna just a couple of weeks ago.
"I don't feel like I need to comment on this".
"My first-round match here wasn't great, so today was better, and I need to keep that up against Kevin, obviously, if I want to have a chance to stay here in London". "I could win and still not make it, so from that standpoint it's not in my power", Federer said.