Hi Bob,
I have developed a few niches, and maybe the ways I found those will give you some ideas.
Back in the late 90s, I worked on a few medical practice websites. Based on that experience, I began to develop a niche building websites and doing online marketing (including but not limited to SEO) for medical practices. We have worked with many medical specialties, but along the way we began working with many urgent care practices, and thus developed an even stronger program for this specialty. We can do a great job for just about any type of practice; for urgent care, we can do even more. We are now looking into replicating this deeper focus with other medical specialties.
So, the lesson here is to examine your own current client base, and look for industries where you can replicate what you are already doing. Or if you don't yet have a client base, focus on your past work experience. Based on the options you come up with, I'd consider things like the level of competition for others focusing on that niche, and how much you like working with that type of business.
Of course, one thing about medical practices is that they are local businesses. We generally don't take on 2 clients in the same market, because then we'd just be competing against ourselves. That said, still have an a huge number of prospects when you consider all of the medical practices out there.
And this leads me to the 2nd niche that we have. By working with medical practices, we learned how to do local. I would occasionally get clients in other industries, and began to realize that local marketing techniques are pretty similar for many industries. So, our 2nd niche is local marketing. On that side of the business, we have a strong focus on our home city of Portland, OR. In addition, since we are already doing local marketing in dozens of other cities around the country, we are learning to target other businesses in the cities where we already have clients.
In general, I think there is a big need for more people to specialize in local SEO.
Hope this helps you find your direction!
Ira