In the close match, Sania forced a tiebreaker in the first set.
Sania's challenge, however, is still alive in both women's and mixed doubles.
Eighth seed Venus had to bring all her experience into play against the 31st seed Sania. In the ultimate analysis, it was the Indian's high percentage of unforced errors that proved decisive.
Full coverage: Australian Open 2008
Sania committed 31 unforced errors to Venus's 19, though there was little to choose as far as winning points on their serve were concerned.
Sania hit 18 winners to Venus's 22, and surprisingly the India's net play was superior to that of the American.
In her first Australian Open three years ago, Sania lost to Venus's sister Serena in the third round.
The Indian star, who had said before the match that she had nothing to lose, battled it out freely matching the American shot for shot but in the tie breaker she could not win a point.
But that did not deter her from fighting it out in the second set till a single break of serve ended her hopes.
Sania beat Swiss Timea Bacsinszky in the second round while Venus won her second round against France's Camille Pin 7-5, 6-4.
