Why it's important
Knowing what the competition is up to is valuable information for any business. It can help you identify your own product and marketing weaknesses. You may even see some features and/or messaging that could resonate with your own audience.
By analyzing where they focus their energy and resources you can get an idea of their current priorities and future concerns. You don't need to compete with every competitor for every keyword - just the ones that end up making sense for your business.
Getting it done
Approach competitor analysis from two directions using a tool such as KeywordSpy or SpyFu (both of these are free): Discover which keywords your competitors rank for, and discover who your competition is for your target keywords.
You can also use PPC competitor analysis tools to learn who's bidding on keywords for your industry.
Don't base your own keyword strategy entirely on what the competition is doing, but use it to inform yourself of audience preferences and market trends.
External resources