Pep Guardiola says Manchester City "might not be able to compete" with the best teams in Europe and have to "accept that reality".
His side lost 2-1 to local rivals Manchester United in the Premier League on Saturday and trail leaders Liverpool by 14 points.
Last season, City won the domestic treble and retained the league title but have lost four games in 2019-20.
"We have to improve and accept it and move forward," said Guardiola.
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"[Manchester] United have the quality to defend and the quality to attack on the counter-attack and you have to accept that," he added.
"That is the level we face against Liverpool, Manchester United, Barcelona, Real Madrid, Juventus. They are the teams we have to face and the reality is maybe we are not able now to compete with them.
"Maybe we need to live that as a club to improve, to accept the reality now and improve."
Manchester City won the first of their back-to-back league titles in 2017-18 with a record-breaking 100 points but were beaten in the Champions League quarter-finals by Liverpool.
They reached the same stage of the European competition last season before being knocked out by runners-up Tottenham but did go on to become the first English team to win the Premier League, FA Cup and Carabao Cup in the same campaign.
Despite struggling in the league this season, City are already through to the knockout stages of the Champions League ahead of Wednesday's final group game against Dinamo Zagreb.
They play Oxford United of League One in the Carabao Cup quarter-finals later this month and are bidding to win that competition for a third successive season.
They have also been given a kind draw against League Two Port Vale for the start of their FA Cup defence in January.
"The reality is we are 14 points behind for the mistakes we have done, for the quality of our opponents and especially, as well, the things we cannot control. That is the reality but we have to continue," Guardiola said.
"We are at the beginning of December and we have other competitions to play in and other games to fight and improve on.
"We are not thinking of winning the Champions League, I am not thinking about how many points we need or how many points they have to drop. We are trying to win games, to win the next one."