I am using dds textures on my model as it seems to be the format with the smallest file size and I am trying to keep my model under 20mb before releasing it to the comunity.
I have run into an issue though; For the skin texture dds works great enabling me to have a 2048 by 2048 texture with a minimal file footprint but when I try to use dds on the normal map it wont let me assign an apha map to control the specularity.
Sounds like you are saving it as dxt1. You have to save it as dxt3 - explicit alpha instead. Using dds for normalmaps might not be a good idea however, as you will most likely get artifacts, even when you turn the compression from color to normalmap. But give it a try, maybe it works for you