I want two NPCs to fight and other NPCs to simply spectate and cheer.

Do I simply set them up in opposing factions, remove all their weapons so they fight with fists only and make them essential?

Or is there another way?

For the spectators, in order to ensure they don't get involved will simply setting Morality at 'any crime' stop them from getting involved?

Combat makes people behave differently, it's better to avoid it altogether. Give them packages based on UseWeaponAlreadyHeld, and make sure Allow combat start on hit is false.

There's a scene like this that plays the first time the player enters Jorrvaskr--two of the Companions are fist-fighting, and the rest are standing around, cheering them on. I don't have the CK open so can't give you the particulars, but I'd suggest taking a look at that scene.