Media playback is not supported on this device
The Baku result comes a month after Northern Ireland suffered a 3-2 loss at the hands of minnows Luxembourg.
"The players have made it difficult for themselves," added O'Neill.
"I'm not going to say we've been progressing at a rate of knots. We're progressing in small steps and taking a few setbacks. This was another one."
He added: "Some of our performances have been good but we just have to live with the results and they've been poor, there's no getting away from that."
Media playback is not supported on this device
Friday night's defeat, courtesy of goals from Rufat Dadasov and Mahir Shukurov, means Northern Ireland have taken just two points from a possible 12 against the two lowest ranked teams in their World Cup qualifying group.
They now have just one match - on Tuesday against Israel - to avoid an embarrassing bottom-placed.
The result was compounded by Jonny Evans's injury-time red card for a crude foul that led directly to Azerbaijan's second.
Evans will now be suspended for the game in Israel, alongside Gareth McAuley, who was booked for talking back to the referee, and Oliver Norwood.
O'Neill declined to hold his tongue on those incidents, although insists his side have been harshly treated by officials over the course of the qualification group.
"Jonny has admitted it was frustration so that was stupid for a player of his level and the level he plays at with Manchester United. He should know better," O'Neill added.
"You could see frustration creeping in to the players as the game went on, not only towards the opposition but also to the referee.
"We have to learn to control that. And as for Gareth, anything for dissent is inexcusable, simple as that.
"But for a team like us, who who have committed virtually the fewest fouls in Europe, to have the disciplinary record we have is a bit of a joke."
Northern Ireland manager Michael O'Neill says the 2-0 World Cup qualifier defeat by Azerbaijan is another "harsh lesson" for his team.