Dortmund, title contenders ahead of the season, have lost their last three home games and trail league leaders Bayer Leverkusen by six points after 11 matches.
"We are all grateful to Lucien Favre for his excellent work over the past two-and-a-half year, in which he and his team won two runner-up championships. As a professional and as a person, Lucien Favre is beyond any doubt," Dortmund chairman Hans-Joachim Watzke said in a statement.
Edin Terzic, Otto Addo and Sebastian Geppert will take over until the end of the season amid a tight schedule which sees Dortmund face away trips to Werder Bremen on Tuesday, to Union Berlin on Friday, and then to 2. Bundesliga club Braunschweig in the German Cup on Dec. 22.
Terzic, a youth coach who has also worked as an assistant at West Ham and Besiktas, took charge of the Sunday afternoon training session.
"It is very difficult to take this step," sporting director Michael Zorc said. "But we believe because of the negative developments lately that there is a need to act."
After just one point from their last three games against Cologne, Frankfurt and Stuttgart, Dortmund have dropped to fifth in the Bundesliga and face a fight to return to the Champions League next season.
"It was a disaster. It was bad," Favre said after the loss. "We weren't good at winning the ball. We made too many big mistakes. It's hard to explain. If you're not good at winning the ball, and I mean the whole team, then you have a problem. Stuttgart played well, but we were very, very poor. You can't get away with that."
Despite players pushing to break through into the European elite such as Erling Haaland, Jadon Sancho, Jude Bellingham and United States international Gio Reyna, as well as established and experienced stars like Marco Reus, Mats Hummels and Axel Witsel, Dortmund have struggled this season.
Dortmund have scored only four of their 23 league goals in the first 45 minutes and have conceded first in their last four games, of which they only won one when Haaland scored four in one half at Hertha Berlin on Nov. 22.
Favre was appointed by Dortmund in the summer of 2018 following a turbulent season at the club which saw them qualify for the Champions League thanks to goal difference.
In his first year, Dortmund led the Bundesliga for large parts of the season, but ultimately lost out on the title following a home defeat to local rivals Schalke.
In the 2019-20 season, Favre's Dortmund once again finished runners-up, having challenged until a 1-0 home defeat to Bayern in late May following the restart of the Bundesliga amid the coronavirus pandemic.
His three-year contract was due to run out at the end of the season.
Information from Reuters was used in this report.