Marketing - Competitor goes out of business

That is clearly a hot space if Picnik was purchased by Google and Instagram by Facebook. You could setup Google alerts for phrases where people are posting or looking for alternatives. Also do Twitter real time discussion searches for the term, and try to connect individual with prospects and get them to try your software. Buy Google PPC adwords around picnik and see if you can find prospects looking for alteratives. Build an importer from picnik into your app and get people talking about it.

How should you react? Be happy there is one less competitor, be sad Google and Facebook bought the competitor instead of you ;) - Continue to preserver and become a threat to them and make money or get your own buy out.

A similar thing happened to me recently, my biggest competitor decided to shut down their service. I was able to get a big boost in sales for the few months around their closure by targeting their customers. The step I took in the order I think had the most impact were:

1. Reach out to a few key users that are vocal on relevant forums and in this case the competitor's own forums. This meant when the competitor's customers asked what their alternative options were on the competitor's forums my service invariably got mentioned,

2. I went to the effort of writing a migration tool (took about a week) and then wrote an article about it on my blog, tweeted it etc,

3. Did an interview with a respected industry web site. This one just fell in my lap,

4. Ran an adwords campaign with the competitor's name and the word "alternative". This didn't really result in much traffic and I wouldn't bother with it in hindsight.