diff --git a/packages/config-loader/src/lib/transform/include.test.ts b/packages/config-loader/src/lib/transform/include.test.ts
index 1724159e56..81c6cfb63b 100644
--- a/packages/config-loader/src/lib/transform/include.test.ts
+++ b/packages/config-loader/src/lib/transform/include.test.ts
@@ -14,11 +14,14 @@
  * limitations under the License.
  */
 
+import { JsonValue } from '@backstage/config';
 import * as os from 'os';
 import { resolve as resolvePath } from 'path';
 import { createIncludeTransform } from './include';
 
 const root = os.platform() === 'win32' ? 'C:\\' : '/';
+const substituteMe = '${MY_SUBSTITUTION}';
+const mySubstitution = 'fooSubstitution';
 
 const env = jest.fn(async (name: string) => {
   return ({
@@ -26,6 +29,24 @@ const env = jest.fn(async (name: string) => {
   } as { [name: string]: string })[name];
 });
 
+const substitute = jest.fn(
+  async (
+    value: JsonValue,
+  ): Promise<{ applied: boolean; value?: JsonValue }> => {
+    if (typeof value !== 'string') {
+      return { applied: false };
+    }
+    if (value.includes(substituteMe)) {
+      return {
+        applied: true,
+        value: value.replace(substituteMe, mySubstitution),
+      };
+    }
+
+    return { applied: false };
+  },
+);
+
 const readFile = jest.fn(async (path: string) => {
   const content = ({
     [resolvePath(root, 'my-secret')]: 'secret',
@@ -33,6 +54,7 @@ const readFile = jest.fn(async (path: string) => {
     [resolvePath(root, 'my-data.yaml')]: 'some:\n yaml:\n  key: 7',
     [resolvePath(root, 'my-data.yml')]: 'different: { key: hello }',
     [resolvePath(root, 'invalid.yaml')]: 'foo: [}',
+    [resolvePath(root, `${mySubstitution}/my-data.json`)]: '{"foo":"bar"}',
   } as { [key: string]: string })[path];
 
   if (!content) {
@@ -41,7 +63,7 @@ const readFile = jest.fn(async (path: string) => {
   return content;
 });
 
-const includeTransform = createIncludeTransform(env, readFile);
+const includeTransform = createIncludeTransform(env, readFile, substitute);
 
 describe('includeTransform', () => {
   it('should not transform unknown values', async () => {
@@ -136,4 +158,14 @@ describe('includeTransform', () => {
       'failed to parse included file invalid.yaml, YAMLSyntaxError: Flow sequence contains an unexpected }',
     );
   });
+
+  it('should call substitute prior to handling includes directive', async () => {
+    await expect(
+      includeTransform({ $include: `${substituteMe}/my-data.json` }, root),
+    ).resolves.toEqual({
+      applied: true,
+      value: { foo: 'bar' },
+      newBaseDir: `/${mySubstitution}`,
+    });
+  });
 });
diff --git a/packages/config-loader/src/lib/transform/include.ts b/packages/config-loader/src/lib/transform/include.ts
index 1a6963672a..bffc2e0184 100644
--- a/packages/config-loader/src/lib/transform/include.ts
+++ b/packages/config-loader/src/lib/transform/include.ts
@@ -35,6 +35,7 @@ const includeFileParser: {
 export function createIncludeTransform(
   env: EnvFunc,
   readFile: ReadFileFunc,
+  substitute: TransformFunc,
 ): TransformFunc {
   return async (input: JsonValue, baseDir: string) => {
     if (!isObject(input)) {
@@ -53,7 +54,11 @@ export function createIncludeTransform(
       return { applied: false };
     }
 
-    const includeValue = input[includeKey];
+    const rawIncludedValue = input[includeKey];
+    const substituteResults = await substitute(rawIncludedValue!, baseDir);
+    const includeValue = substituteResults.applied
+      ? substituteResults.value
+      : rawIncludedValue;
     if (typeof includeValue !== 'string') {
       throw new Error(`${includeKey} include value is not a string`);
     }
diff --git a/packages/config-loader/src/lib/transform/types.ts b/packages/config-loader/src/lib/transform/types.ts
index c13f01d016..e7ebb0fddc 100644
--- a/packages/config-loader/src/lib/transform/types.ts
+++ b/packages/config-loader/src/lib/transform/types.ts
@@ -23,13 +23,8 @@ export type ReadFileFunc = (path: string) => Promise<string>;
 export type TransformFunc = (
   value: JsonValue,
   baseDir: string,
-) => Promise<
-  | {
-      applied: false;
-    }
-  | {
-      applied: true;
-      value: JsonValue | undefined;
-      newBaseDir?: string | undefined;
-    }
->;
+) => Promise<{
+  applied: boolean;
+  value?: JsonValue;
+  newBaseDir?: string;
+}>;
diff --git a/packages/config-loader/src/loader.ts b/packages/config-loader/src/loader.ts
index 54e4ab5208..95e5b570ca 100644
--- a/packages/config-loader/src/loader.ts
+++ b/packages/config-loader/src/loader.ts
@@ -75,9 +75,10 @@ export async function loadConfig(
         fs.readFile(resolvePath(dir, path), 'utf8');
 
       const input = yaml.parse(await readFile(configPath));
+      const substitutionTransform = createSubstitutionTransform(env);
       const data = await applyConfigTransforms(dir, input, [
-        createIncludeTransform(env, readFile),
-        createSubstitutionTransform(env),
+        createIncludeTransform(env, readFile, substitutionTransform),
+        substitutionTransform,
       ]);
 
       configs.push({ data, context: basename(configPath) });