Couple of articles I've written that may help:
Building Links? 13 Ways To Determine Link Quality. | Web Development Blog
Avoiding Common Search Engine Optimization Rip-Offs | Web Development Blog
Regarding targeting certain cities or states, there have already been some great suggestions (without having to go the PPC route). Make sure you add the site to Google Local and Yahoo Local. Also make sure the address of the firm, with the state spelled out, is in the footer (or somewhere) on each page.
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Google isn't as dumb as you think.