The shift marks a major upheaval in the once cosy and profitable mobile phone market, and the company's decision follows moves by competitors to adapt to the changing habits of German customers.
"We saw customer behaviour fundamentally change in the fourth quarter of last year. It even surprised us," Telefonica Deutschland Chief Executive Rene Schuster told Reuters.
"We are used to working and living in a fast-moving industry. It even happened faster than we thought. In technology the Germans are slow adopters, but this consumer behaviour is surprising."
As of March 1 Telefonica Deutschland, the fourth and smallest player in Europe's biggest mobile market, will offer phone and text services for free, combined with data packages from 50MB to 500 MB in its 3G network and 2-5 GB in 4G.
Packages range from 19.99-49.99 euros per month.
The move comes only weeks after Vodafone's German unit, the country's biggest mobile operator, started selling 'Red Tariffs' of 4G services from 79.99 euros per month and 3G from 29.99 euros, with 4G for 10 euros per month extra.
"More than 50 percent of our installed base uses data every single day. Smartphones are not about using voice calls and SMS; it is a clock, it tells me what the weather is, it is about e-mails," Schuster said.
"You need to provide a secure environment, where consumers are willing to use the smartphone more and not be afraid of a price shock."
Spain's Telefonica in October floated 23 percent of its German unit for 1.45 billion euros ($1.9 billion). At the time it warned revenues from its wireless services would grow at a lower rate than in previous quarters.
Third-quarter revenues from wireless services rose 5.6 percent, slowing from an 8.6 percent rise the previous quarter.
Vodafone, Deutsche Telekom and KPN'S E-Plus are Germany's top three players and record operating margins around or just below 40 percent but are battling declining margins.
Telefonica Deutschland, which has a different definition of operating profit, has a margin of around 25 percent, and reported an increase in the last quarter.
Schuster does not expect that Telefonica's margins to be impacted. "We don't think this a margin game whatsoever," he said. "We expect to generate more revenue and for our margins to improve, not drastically," he said.
With competition getting fiercer, Schuster remains open for network sharing deals. "We are always in dialogue with everybody but there is nothing on the table.