Schumacher, 43, the sport's most successful driver with a record 91 Grand Prix victories, will be replaced in 2013 by Lewis Hamilton, who has signed a three-year deal with the British-based team.
Friday's decision was a disappointing end to an unsuccessful stint at Mercedes and another big dent in Schumacher's once sparkling racing record.
Critics and some fans had viewed his return sceptically, saying Schumacher had nothing more to prove and too much to lose going up against a younger generation of drivers that included fellow-German Sebastian Vettel.
Schumacher, who had retired in 2006, at the time claimed he had come full circle after Mercedes' support early in his career.
"Mercedes supported me for so many years when I began my Formula 1 career and now I can hopefully give something back to the brand with the star," he said on the day of his official presentation."
Vettel, almost 20 years his junior, went on to win consecutive world titles in 2010 and 2011, completely overshadowing Schumacher's return to racing, especially in his native Germany.
By Friday even his most die-hard Schumacher fans had come to the bitter realisation his comeback had not been what they expected.
"I have had three nice years with the team which unfortunately did not go as well as we all would have wanted on the sporting side," Schumacher said in a brief statement .
Schumacher made his F1 debut at Spa in 1991 and took his first race win there the following year with Benetton, going on to win seven world titles with them and Ferrari.
But he has not won a race since 2006, with a third place in Valencia this year his only podium spot. The once shrewd tactician had even failed to realise it at the time of the race until the team told him after he crossed the line.
Once Formula One's leading player, with his return Schumacher quickly became a character actor in a sport that had long found fresh-faced leading men to replace him.
His once trademark ice cool driving and steely resolve for victory was now being labelled as reckless driving in a bid to catch up with the competition that was gradually pulling away for good.
His latest transgression, smashing into the back of rookie Jean-Eric Vergne's Toro Rosso at the Singapore Grand Prix last week landed the German a 10-place penalty for the Japanese Grand Prix in Suzuka on Oct. 7 on what could be the start of his farewell tour.
"He has no reason for any regret even though his comeback did not go as he would have liked," said Austrian Niki Lauda, a triple world champion, who will join Mercedes as a non-executive chairman of the board.
"His statue will not see any cracks because of that. He just did not have a top car in those three years."
Even though some may think - including former driver Marc Surer - that Schumacher could potentially opt to continue with another, albeit smaller, team, fans, especially in Germany are preparing for racing life without him.
"Personally for me he is first big (German) sports icon, the one person representing German sport," said Germany's Olympic discus champion Robert Harting, a racing fan.
"Obviously it is a great loss when it ends but now others need to jump in. I obviously hope Sebastian (Vettel) will do it."