After the first three games of this season's Champions League, Los Blancos sit in second place in Group D with six points - one point behind the Bundesliga outfit.
The 2-1 defeat to Jurgen Klopp's men in the previous round of fixtures leaves Madrid with work to do if they are to qualify for the knockout stages as group winners and Butragueno says failure is not an option.
"It's a vital game," the former Spain international told Digital Plus. "We want to be top of the group because the ties in the last 16 can be very complicated if you don't finish first. We cannot fail in this.
"Afterwards, we have to go to Manchester, which will be a very difficult game because [Manchester] City have to win their last three games. We cannot fail in our home matches."
Butragueno also rejected any suggestions of complacency in his former club's 4-0 win over Zaragoza, whilst taking the opportunity to praise the contributions of recent recruits Michael Essien and Luka Modric.
"It's good news that two midfielders have scored," he continued.
"Essien scored a good goal and Modric is becoming more involved and will increase his level. We'll see on Tuesday, which looks like will be very important for us."