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Also, if you have a nationwide client selling widgets and then get a call from someone selling widgets locally, do you take them on? You can pick more locallized search terms for the local client. Or could this have the potential of blowing up also?
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Either way I don't think it's a good idea to take on anyone in the same market, or anyone that wants to target the same keywords.
Why not refer the second client to another SEO? - You'll gain a reputation as an honest business person by telling the second client that you cannot take them on for client competition reasons, and you would gain a freind in another SEO by refering clients to them. They could do the same for you. Quid Pro Quo