The once-dominant team took only one win last year and dropped to third overall after a run of eight successive constructors' crowns.
Hamilton told reporters on Friday at the season-opening Bahrain Grand Prix that Mercedes were on the wrong track and, after Russell qualified sixth and his team mate seventh, Wolff agreed a change of direction was needed.
"I don't think this package is going to be competitive eventually," said the Austrian of a car that stands out for its slimmed-down sidepods.
"We got it wrong last year, we thought we could fix it by sticking to this concept of car and it didn't work out," he explained.
"So we just need to switch our focus on to what we believe can be the right direction -- what is it that we are missing and therefore those data points from this weekend are very important."
Wolff said the team needed to regroup and decide the development direction.
"I'm sure we can win races this season, but it's really the mid- and long-term that we need to look at and which decisions we need to take," he said.
"We gave it our best shot and the moment comes when the stopwatch comes out. And that showed us that it's simply not good enough. We haven't got enough downforce and we need to find solutions to fix that."
Wolff said it might be possible to "turn the ship around" this year and he did not want to discount anything while remaining realistic.
Technical director Mike Elliott said on Friday that changes were already in the pipeline.
"We've got a different bodywork coming, it won't be the same as other people's and it won't be the same as what we've got," he told reporters.
Mercedes-powered Aston Martin, who ended last season seventh overall, set the pace in practice and had double world champion Fernando Alonso qualify fifth.
"They gained two seconds in half a year and their car is half ours, from the engine and gearbox and rear suspension and the same wind tunnel," said Wolff.
"There's a lot of parallels and we just need to acknowledge that they have done an outstanding job."
