I've just written this rather large article on optimising for local search, specifically for Birmingham (it's a place I know, so I wrote about it).
Now, it speaks a lot about how to promote a website specifically for people who are either adding an area to their search term, like “Cycle shop Birmingham”, or are searching from within a particular area, because yes, Google knows where you are.
When you search for something, if it's the sort of business that requires you to potentially turn up, such as a cafe or bike shop etc, then it would be useful if the results are from your current vicinity.
You may have noticed that when searching using your phone the results are indeed based on where you are. Seeing as you have a GPS receiver, it's easy to see how Google could know where you currently are in the world and provide results to match.
You don't have to type “Cafe in Birmingham” if you are indeed looking at the cathedral. You're going to get relevant results.
Appending the search term
However, in some cases you might need to search for an area that you're not currently in.
For example, if you want to search for a coffee shop in Leeds but you're currently at junction 33 of the M1.
In these cases, people will type the search term and the location, “Coffee shop Leeds”.
This is why we optimise for local listing.
The question arises, then, what if you're a global and local business?
You offer goods to walk-in customers but you also offer mail-order to the world? Surely by optimising locally you are ruining your chances of being found by people outside your local area?
Local optimisation isn't to the detriment of global optimises. Rather, it complements it.
Indeed, local optimisation will help your global ranking.
Any work you do to make your website more popular will have a knock-on effect to both your local ranking and your global ranking. It all helps.
So if your baking shop serves the best ingredients to people within a five mile radius, but you also offer mail-order to people in the USA, continue creating content for both – you'll reap the rewards of both types of customers.