The 23-year-old was on the end of a surprise loss to the American qualifier Bradley Klahn, the world number 104 winning 4-6, 6-4, 6-3.
The talented but temperamental Kyrgios, who is ranked 38th in the world, has a chequered history with Shanghai.
Last year he was fined after he stormed off mid-way through his first-round match, with jeers and boos ringing in his ears from the crowd.
Two years ago he argued with spectators and was accused of giving away points in another defeat.
The fiery Australian was fined and suspended on that occasion.
The Croatian, 21, won 4-6, 6-4, 6-3 and will play Klahn in the next round.
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