For clarification
- Modern Saxons would be Franconian (there's not enough of a cultural difference between Thuringen and Sachsen to differentiate, imo). Transylvanian germans were that type of saxons. This comes mostly from the destruction of the old saxon dynasty's power.
- Saxons of that time period would be in Brunswick, and the german parts of Oldenburg (which should be Frisian on the coast) and Holstein (so Hamburg), along with the german settlers in Brandenburg, Mecklemburg and Pommerania, and the province of Münster. The franconian spoken in this new duchy of Saxony is what mostly became standard modern german.
- If Frisian is added, it should be West Germanic, unlike Dutch which is descended from a local Low German dialect. It would likely cover the Frisian provinces (including the northern half of Holland, if I remember the map correctly), along with coastal Oldenburg. It would be hard to represent Northern Frisia unless Schleswig was made entirely frisian since there's too few provinces.
- If there's any divisions done in the south: Rhenish is Franconian, as is Lorraine's Germans. No there shouldn't be a special culture for every single little duchy in the empire. Similarly Switzerland and Alsace would be Alemanic or Swabian (which the native colloquial Swiss german is a dialect of to this day), and Austria and Carinthia should probably just fall under a broad Bavarian lump. The four stem duchies plus a reasonable distribution of the marches should be good enough.
- Cultures of the time were somewhat more distinct, yes there were rebellions in the north, and the cultural dynamics in the game (such as adopting liege culture, conversion, etc).
Ultimately it remains that both lumping and dividing cultures heavily causes issues in that it's deterministic, but I don't think the game can quite model dozens of divergent historical paths in that regard (like "what if the republic of Jamtland remained independent long enough for the local dialect to be considered a language" - they're still considered relatively distinctive dialects to this day)