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Yes I do mean if you are physically playing on the server rather than hosting a dedicated server. Playing on it will mean you are affecting performance yourself, so slinging around lots of bulky textures will add more load.
Yes by the original renderer I mean the DX7 and old GL renderers.
Anyone using original renderers is limited in size of supported textures, hence merging is needed to work for all.
DDS = Direct Draw Surface, it is the format used in DirectX for handling S3TC/DXT compressed bitmaps. These can be used by GFX cards without needing to be decompressed. This makes it faster to load and use, while leaving more space in GFX RAM for even more textures.
S3TC/DXT/DDS compression and transparencies viewtopic.php?f=5&t=5956
If you export from GIMP or Photoshop (plugin required) it will be saved as a DDS file which UEd can import.
However you can compress in UEd. With UEd2.x you do it during import, but with UEd3 you can also do it after you imported it.
If using the DXT modes you can avoid quality compromise by compressing 24/32 bit images with modes 3 and 5
Always use mode 1 for compressing 8bit images.
BTW make sure you have installed the final full DX9 runtime distro, as the DX installed with newer windows is lacking some of the files.