Martino's side drew 0-0 with New Zealand to qualify comfortably while Italy finished bottom after crashing 3-2 to Slovakia having drawn 1-1 with Paraguay earlier in the tournament.
"We didn't play well. We didn't have mobility and we were very imprecise with our passing. We achieved our goal of qualifying but we must focus on playing better if we want to get through the next round," Martino told reporters.
The Paraguay coach, whose team go through with Slovakia, said his players had played with some fear and nervousness.
"The players on the field were thinking, 'We are good enough to win but if they get us on the break we are out' and that affected their performance," he said.
"In the last 16, you either win or you are out and so the players will start the game thinking in a very different way," he said.
Striker Roque Santa Cruz agreed that the performance was below-par but credited New Zealand for their defending.
"We don't feel happy because we didn't win but New Zealand were a very hard opponent and it is very difficult to play against them. I think we had a lack of rhythm and dynamism," he said.
"In the first half, New Zealand handled our attacking play very well because they were fresh. In the second half they were more tired and we got more chances.
"But it was a game where we had to be more patient," he said.
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